Economic growth continues to decelerate across the Asia Pacific region. Domestic economies have not been robust enough to offset weakness in commodities and exports, and both revenue and earnings expectations were adjusted downward by 1% during the second quarter.1 Because growth is scarce, investors have been crowding into the highest-growth and highest-quality stocks; within Asia and Japan, this group of stocks is now trading at the highest premium to the rest of the market that we’ve seen in the past 20 years.2
These are the types of businesses the Invesco International and Global Growth team prefers, but valuations have become “glamorous” and reached levels that do not make sense. As such, opportunities for us to invest in Asia have been scattered. We’re simply not seeing broad-based opportunities that align with our focus on earnings, quality and valuation (EQV). (This is similar to the situation we’re seeing in emerging markets.)
Trimming positions in Japan
Six months ago, Japan was the region where the team had deployed the most capital. Due to the market’s strong performance, we trimmed some positions in the second quarter where we believe valuations had become stretched. The Japanese market now trades at 16x earnings, as represented by the MSCI Japan Index, which is a 21% premium to the rest of Asia, as represented by the MSCI AC Asia Pacific ex Japan Index.1
While earnings expectations in Japan were revised upward by 2% in the second quarter1 — bucking the trend seen throughout the rest of Asia — it’s important to understand that the improvement is due to continued weakening of the Japanese yen. If you stripped out the effects of currency, earnings revisions would be negative.
There are reasons to be hopeful, however, as Japanese consumers have just started to experience positive real wage growth, and companies are beginning to make progress on reforms. There is a growing recognition of the importance of return on equity among Japanese management teams, and they’re beginning to take action to improve returns. Unfortunately, very few companies have communicated their strategy for driving returns higher. Until managements can articulate their goal and how they plan get there, we cannot properly assess the value they can create.
One new opportunity in Australia
For the Invesco International and Global Growth team, the one new Asia Pacific holding we added during the second quarter was Aurizon Holdings (0.76% of Invesco International Growth Fund, and 0.99% of Invesco Asia Pacific Growth Fund as of June 30, 2015).
This Australian-based railroad operator has embarked on a significant cost reduction program in its transformation from a former government-owned and operated model to a privately run business. Nearly half of its operating profits are generated through a regulated return, and the other half are covered by long-term take-or-pay contracts. We believe this is a business that can generate earnings growth in the teens, and its price-earnings ratio was 15x as of May 4, 2015, which was a discount to local and global peers.3
Read more from the Invesco International and Global Growth team:
Volatility and growth: Two critical questions for international markets
Emerging markets: Zeroing in on targeted opportunities
1 Source: FactSet Research Systems, Inc. as of June 30, 2015
2 Source: Merrill Lynch as of June 30, 2015
3 Source: Bloomberg, LP as of June 30, 2015
Important information
The MSCI Japan Index measures the performance of the large- and mid-cap segments of the Japanese market.
The MSCI AC Asia Pacific ex-Japan Index is an unmanaged index considered representative of Pacific region stocks, excluding Japan. An investment cannot be made in an index.
Return on equity (ROE) is net income divided by net worth.
Price-earnings (P/E) ratio, also called multiple, measures a stock’s valuation by dividing its share price by its earnings per share.
Holdings are subject to change and are not buy/sell recommendations.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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Unattractive ‘glamour stocks’ lead the way in Asia Pacific by Invesco Blog
